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Financial Planning > Tax Planning

PPACA Cadillac plan tax pie: Hard to slice?

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Implementing a new “Cadillac plan” tax on high-cost employer health coverage could lead to “mind-bending tax administration issues,” according to Mark Holloway.

Holloway, a benefits compliance law specialist at Lockton Companies, makes that prediction in an analysis of a new Internal Revenue Service (IRS) Cadillac plan request for information, given in the IRS Notice 2015-52.

In the notice, IRS officials ask for ideas about how they should implement Internal Revenue Code (IRC) Section 4980I, the section of the tax law that gives the Cadillac plan tax rules.

Because a health insurer administering the tax cannot deduct the excise tax amount from its own taxable income, the full amount an insurer will expect to get from an employer for paying the tax may be about 60 percent bigger than the tax payment itself, Holloway warns in the analysis.

“Do you have a headache yet?” Holloway asks. “I bet the IRS does, as it tries to solicit comments on the best way to structure and pay the tax.”

Drafters of the Patient Protection and Affordable Care Act of 2010 (PPACA) added the excise tax, in an effort to raise revenue, encourage employers to hold down health care costs, and reduce the share of federal health insurance tax breaks going to high-income workers with rich health benefits. 

See also: Republicans propose group health exclusion cap

The provision calls for the IRS to have “covered providers” pay a 40 percent excise tax on the “excess benefits” in high-cost plans for the taxable years starting after Dec. 31, 2017. In the first year, the tax is set to apply to employer benefits packages with a cost over $10,000 for an individual and over $27,500 for a family. 

Holloway notes that the total value of the 2018 health benefits package for Alan, a hypothetical employee, could include, for example, fully insured major medical insurance with a value of $10,000, a $2,000 contribution to a flexible spending arrangement (FSA) and a $700 self-insured health reimbursement arrangement (HRA) benefit.

The health insurer and the benefit plan administrator that handles the employer’s FSA program will have no obvious way to know whether Alan has a health benefits package with a cost over $12,000 because the insurer is getting only $10,000 in premiums, and the FSA administrator is handling just $2,000 in new contributions, Holloway says.

Alan’s employer will have to tell the insurer and the FSA administrator that Alan is over the Cadillac plan limit, Holloway says.

PPACA requires the coverage providers — which in this case are the health insurer, the FSA and the HRA — to allocate the Cadillac plan tax responsibility proportionately.

In this example, Holloway says, the coverage providers might owe a total of $1,000 in Cadillac plan excise taxes for Alan’s benefits package, with $787 being the responsibility of the health insurer, $157 being the responsibility of the FSA, and $55 being the responsibility of the HRA.

The insurer will want Alan’s employer to include a payment for the excise tax liability with the payment for Alan’s coverage, but, for the insurer, the total cost of the excise tax liability could be much bigger than the tax payment, Holloway says.

The insurer cannot deduct the excise tax payment from its taxable income. Because of that, Holloway says, the insurer will have to multiply the $787 excise tax payment times a value equal to 1 plus the insurer’s own marginal tax rate to calculate the impact of the excise tax payment.

If the insurer pays a $787 excise tax to the IRS for Alan, and the insurer has a marginal state and federal income tax rate of 27 percent, the insurer will have to get an amount equal to $787 times 1.27, or $1,000 from the employer to offset the excise tax impact, Holloway says.

The insurer may also want to bill Alan’s employer for the $270 in income taxes the insurer will owe on the $1,000 in extra Cadillac plan tax reimbursement-related revenue, and the insurer may also want to impose a Cadillac plan tax administrative fee, Holloway says.

That means the insurer could end up billing Alan’s employer for $787 for the tax, $213 for the nondeductible tax-payment revenue, $270 for the extra $1,000 in excise-tax-related payment revenue, and excise tax administrative fees, Holloway says.

See also: IRS wants your advice about the Cadillac plan tax 


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